At our last board meeting, Josh James, my friend and mentor, brought up his famous “magic number,” which he uses to determine the opportunity strength of a SaaS company.
Josh suggested that according to the XANT magic number, we were in a great position to accelerate growth by investing aggressively in sales and marketing.
But instead of stepping on the gas as I thought I was doing, he argued I was tapping on the brakes, effectively stunting the company’s already-explosive growth.
On the surface, that seemed counterintuitive because XANT continues to achieve aggressive sales goals.
But it also raised a crucial question that every SaaS CEO must face:
When should you bet big on growth?
This is a tricky issue with a lot of moving targets. Here are three key factors that will help you determine whether you have put your company in position to scale:
1. Is the market ready?
The first thing you want to do is clearly define your market: How big is it, and how mature is it? It’s foolish to dump money into marketing if you can’t quantify the opportunity.
In his groundbreaking book “Crossing the Chasm,” Geoffrey Moore describes how you can evaluate the maturity of your market based on the categories of customers who are adopting your technology.
Moore explains that disruptive products pass through the following phases of customer adoption: innovators, early adopters, early majority, late majority and laggards.
The sweet spot for a SaaS company is when your software crosses the chasm and catches on among the early and late majorities. That’s when large enterprise clients start to use your technology at a frenetic pace.
For example, we’re seeing companies like Dell, ADP, IBM, HP, Google and LinkedIn deploying massive inside sales teams with thousands of reps. It’s no longer a secret that inside sales generates new customers at a fraction of the cost of traditional field sales.
When industry associations start to bubble up and analysts begin to cover your space, those are also strong indicators that your market is maturing.
Inside sales is exploding as an industry, and that’s one reason Josh James has been pushing me to accelerate our growth. He wants XANT to capitalize on the enormous opportunity that exists in the market.
2. Will it float?
The size and maturity of your market are irrelevant if you don’t have a viable, stable product that meets the expectations of the demand. That seems like an easy thing to accomplish, until you actually try to pull it off.
So many SaaS companies have failed because they didn’t have the capacity to deliver.
Here are a few questions you should ask before you open the floodgates with marketing:
Will your architecture support increased demand?
How will you handle infrastructure and operational bottlenecks?
How quickly can you purchase and install new equipment?
Be honest with yourself. At times, I’ve naively assumed that we were ready to grow faster than we actually were. It’s not uncommon for SaaS companies to struggle with this.
In the past 12 months, we’ve moved aggressively upmarket into the enterprise space. As XANT has added larger clients, we’ve had to adapt quickly to a whole new set of challenges.
For example, you might assume that you can ramp up your server capacity at a moment’s notice — until your supplier can’t ship you servers fast enough. If that happens, you might be forced to rely on subpar equipment, hoping it holds up until reinforcements arrive.
One of my mentors, Fraser Bullock from Sorenson Capital, advised me to invest in infrastructure well beyond what is required to meet current demand.
If you make a leap of faith, Fraser told me, it will accelerate your growth.
XANT has purchased enough hardware to comfortably handle 18 months of future capacity, based on our growth projections. My guess is that it will only last six months. Every time we follow Fraser’s advice, business booms.
3. Do you have the right team and the right machine?
You are not ready to expand until you have mastered operations. Your operational readiness boils down to the well-known trifecta – people, processes and technology.
The key is that you must know the operational triggers for every major decision. Use business intelligence to create a rock-solid recipe for sustainable growth.
Do your leaders have proven playbooks?
Have you built efficient systems?
Are you tracking the right metrics?
Can you identify the real causes of employee turnover and client churn?
Do you know exactly how many employees you must hire to serve new clients?
Can you predict future revenue growth based on your marketing spend?
Josh James created his magic number based on that last question. He now uses it to evaluate the strength of a SaaS company. It’s the same magic number he used to build Omniture into the analytics powerhouse that he sold to Adobe for $1.8 billion.
Here’s how to calculate your magic number:
QRev[X] = Quarterly Recurring Revenue for period X
QRev[X-1] = Quarterly Recurring Revenue for the period preceding X
ExpSM[X-1] = Total Sales and Marketing Expense for the period preceding X
Magic Number = (QRev[X] – Qrev[X-1])*4/ExpSM[X-1]
If your number dips below 0.5, you might need to fix some things in your business. If it climbs above 0.75, you’re primed for growth — and you should invest in sales and marketing.
When your market is primed, your product viable and stable, and your people and processes are predicting growth, then it’s time to dive in.
Josh essentially told me we were well beyond that point — the XANT magic number hovers around 2.
To me, it’s not a huge surprise that we’ve been able to generate revenue so efficiently. That’s what our technology is designed to do.
Nevertheless, Josh thinks it’s time to crack open the wallet and toss some more fuel on the fire. Based on his track record, he’s probably right.
See how XANT accelerates sales through science.
Image credit: Tristan Schmurr